Vilfredo Pareto, an Italian economist and sociologist, is credited with developing a theory that later became know as the Pareto Principal. Pareto attempted to prove that patterns in income and wealth are not random. Since then, his theory has been distilled to the following definition, courtesy of Investopedia: “A principle that asserts that 80% of outcomes (or outputs) result from 20% of all causes (or inputs) for any given event.” You know it as the 80/20 rule.
It doesn’t always work. Sometimes, it’s worth going the extra mile. But often, by prioritizing the 20% of your efforts that makes the biggest splash, you can reduce excess commotion. In that spirit, here are 4 financial best practices that pack a lot of value per “pound.”
Investing: Be There, and Stay There
You could do far worse than to invest according to a sentiment attributed to Woody Allen:
“80% of success is showing up.”
Going back to 1926 and after adjusting for inflation, U.S. stocks have delivered about 7.3% annualized returns to investors who have simply been there, earning what the markets have to offer over the long haul. Those who instead fixate on dodging in and out of hot and cold markets are expected to reduce, rather than improve their end returns. That’s because, when markets recover from a downturn, they often more than make up for the stumble quickly, dramatically, and without warning. Instead of chasing trends, simply stay invested over time.
Portfolio Management: Lean into Asset Allocation
Asset allocation is about investing in appropriate percentages of security types, or asset classes, based on their risk/return “personality.” For example, given your financial goals and risk tolerances, what ratio of stocks versus bonds should you hold? What percentage of small value stocks versus large growth? How much domestic and how much international?
Both practical and academic analyses have found that asset allocation is responsible for a great deal of the return variability across and among different portfolios. So, to build an efficient portfolio, we advise paying the most attention to your overall asset allocation, rather than fussing over particular securities.
Financial Planning: Do It
Also in 80/20 rule fashion, an ounce of financial planning can alleviate pounds of doubt. It connects your resources with your values and priorities. It’s your touchstone when uncertainty eats away at your resolve. It guides how and why you’re investing to begin with.
While your plan may not need to be elaborate, it should reflect the particulars of your situation and your values. A good plan takes into account all of the things that make your situation unique, like your family, your opportunities and needs, your health, and your goals.
A financial plan is a roadmap. Follow it, adjust it, fine-tune it, and then enjoy the fruits of your efforts.
Financial Security: Freeze Your Credit Reports
Even the best-laid financial plans can be thwarted if your assets are exposed to financial scams and identity theft slams. Fortunately, there’s a lot you can do to make sure that doesn’t happen. If we were to pick one punch that delivers among the biggest blows to identity theft it’s the ability to freeze your credit reports.
Freezing your credit with the three major credit bureaus (Equifax, Experian, and TransUnion) is like locking the doors to your home or vehicles. It creates a few extra steps for you, as you’ll need to temporarily lift the freeze when you wish to take out an occasional loan. But it costs nothing to set up and manage. And if an identity thief does get ahold of your information, it should stop them cold if they try taking out lines of credit in your name. This strikes us as an 80/20 trade-off well worth making.
Building Lifetime Wealth, 80/20 Style
Properly applied, the 80/20 rule can help minimize the time and energy you have to put into maximizing your financial well-being. Whether you’re saving for retirement, funding your kids’ college education, preparing for a wealth transfer, applying for insurance, or otherwise managing your hard-earned wealth, we can help you identify and execute these and other actions that matter the most, so you can get back to the rest of your life. Want to learn more? Give us a call today. Consider it part of the 20% of your efforts that should take you far.